Building A Fiduciary Society

While challenges of today are inevitably different from those of the past, the principles are age-old. We must develop a new fiduciary society that guarantees our last-line owners—those mutual fund shareholders and pension fund beneficiaries whose savings are at stake—their rights as investment principals. These rights must include:

1. The right to have their money-manager/agents act solely on their behalf. The client, in short, must be king.

2. The right to rely on due diligence and high professional standards on the part of our money managers and securities analysts who appraise securities for our portfolios.

3. The right to demand some sort of discipline and integrity in the mutual funds and financial products that they offer.

4. The assurance that our agents will act as responsible corporate citizens, restoring to their principals the neglected rights of ownership of stocks, and demanding that corporate directors and managers meet their fiduciary duty to their own shareholders.

5. The establishment of advisory fee structures that meet a “reasonableness” standard based not only on rates but dollar amounts, and their relationship to the fees and structures available to other clients of the manager.

6. The elimination of all conflicts of interest that could preclude the achievement of these goals.

More than parenthetically, I should note that this final provision would seem to preclude the ownership of money management firms by financial conglomerates, now the dominant form of organization in the mutual fund industry. Among today’s 40 largest fund complexes, only six remain privately held. The remaining 34 include 13 firms whose shares are held directly by the public, and an astonishing total of 21 fund managers owned or controlled by U.S. and international financial conglomerates—including Goldman Sachs, Bank of America, Deutsche Bank, ING, John Hancock and Sun Life of Canada. Painful as this separation might be, it is the single most blatant violation of the principle that “no man can serve two masters.”

Of course it will take federal government action to foster the creation of this new fiduciary society that I envision. Above all else, it must be unmistakable that government intends, and is capable of enforcing, standards of trusteeship and fiduciary duty under which money managers operate with the sole purpose and to the exclusive benefit of the interests of their beneficiaries—largely the owners of mutual fund shares and the beneficiaries of our pension plans.

While the government action is essential, however, the new system should be developed in concert with the private investment sector, an Alexander-Hamilton-like sharing of the responsibilities. The task of returning capitalism to its ultimate owners will take time. But the new reality—increasingly visible with each passing day—is that the concept of fiduciary duty is no longer merely an ideal to be debated. It is a vital necessity to be practiced.

What I’ve passionately advocated in these remarks is hardly widely shared among my colleagues and peers. But soon, perhaps, many others will ultimately see the light. Only last week the idea of governance reform got encouraging support from Professor Andrew W. Lo of MIT, one of today’s most respected financial economists: . . . the single most important implication of the financial crisis is about the current state of corporate governance . . . a major wake-up call that we need to change [the rules]. There’s something fundamentally wrong with current corporate governance structures, [and] the kinds of risks that typical corporations face today.

In sum, the change in the rules that I advocate—applying a federal standard of fiduciary duty to their clients for institutional money managers—would be designed in turn to force these managers to use their own ownership position to demand that the managers and directors of the corporations in whose shares they invest honor their own fiduciary duty to the holders of their shares. Finally, it is these two groups that share the responsibility for the prudent stewardship over corporate assets and investment securities alike that have been entrusted to their care, not only reforming today’s flawed and conflict-ridden model, but developing a new model that, at best, will restore traditional ethical mores.

I owe it to Justice Harlan Fiske Stone’s legacy to conclude my remarks with yet one more quotation from his profound and prescient 1934 speech:

In seeking solutions for our social and economic maladjustments, we are too ready to place our reliance on what (the policeman’s nightstick of) the state may command, rather than on what may be given to it as the free offering of good citizenship . . .

Yet we know that unless the urge to individual advantage has other curbs, and unless the more influential elements in society conduct themselves with a disposition to promote the common good, society cannot function . . . especially a society which has largely measured its rewards in terms of material gains . . .

We must (square) our own ethical conceptions with the traditional ethics and ideals of the community at large. (There is) nothing more vital to our own day than that those who act as fiduciaries in the strategic positions of our business civilization, should be held to those standards of scrupulous fidelity which (our) society has the right to demand.

Note: The views expressed in this speech do not necessarily reflect the views of Vanguard’s present management.

Endnotes

1) I’m speaking here of the “buy-side” analysts employed directly by these managers. The conflicts of interest facing “sell-side” analysts were exposed by the investigations of New York Attorney General Spitzer in 2002–2003.

2) Securities & Exchange Commission decision, March 15, 1981.

3) 2002 data: pg. 199, “The Battle for the Soul of Capitalism,” by John C. Bogle, Yale University Press, 2005.

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